Milton Friedman (July 31, 1912 – November 16, 2006) was an American economist and educator, one of the leading proponents of monetarism in the second half of the 20th century. He was awarded the Nobel Memorial Prize in Economics in 1976.[1]

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Life and work

Friedman was one year old when his family moved from Brooklyn, New York, to Rahway, New Jersey, where he grew up. He won a scholarship to Rutgers University, studied mathematics and economics, and earned a bachelor’s degree there in 1932. While at Rutgers he encountered Arthur Burns, then a new assistant professor of economics, whom Friedman ultimately regarded as his mentor and most important influence. Burns introduced him to many things, one of which was Alfred Marshall’s Principles of Economics, and Friedman later would approvingly quote Marshall’s description of economics as "an engine for the discovery of concrete truth." Friedman always insisted that the study of economics was not merely a mathematical game and that it should enable one to understand how the real world works.

Friedman continued his economics studies at the University of Chicago (A.M., 1933) and Columbia University (Ph.D., 1946). While at Chicago he took Jacob Viner’s price theory course and met his future wife, Rose Director. In 1935 he moved to Washington, D.C., to assist with a consumer budget study for the Natural Resources Committee. Two years later Friedman took a job with the National Bureau of Economic Research in New York City so that he could join Simon Kuznets in studies of income and wealth distribution, in particular the distribution of professional incomes. His finding — that barriers to entry maintained by the American Medical Association helped explain the much higher incomes of physicians relative to other comparable professional groups — was the source of some controversy when it was finally published. In the early years of World War II, Friedman worked at the Department of Treasury in the Division of Tax Research and later for the Statistical Research Group at Columbia University , where he was a member of a team that applied statistical analysis to war research. He also taught for one year each at the Universities of Wisconsin and Minnesota. In 1946 he accepted a position in the economics department at the University of Chicago, which, except for occasional sabbaticals or visiting appointments, would be his academic home for the next 30 years. He became a full professor in 1948, was named the Paul Snowden Russell Distinguished Service Professor of Economics in 1962, and became an emeritus professor in 1983.

At Chicago Friedman taught courses in price theory and monetary economics, and in 1953 he established the Money and Banking Workshop — an important forum for faculty members, graduate students working on dissertations in the field, and occasional outside visitors. The workshop became renowned for the presentation and critical appraisal of papers in monetary economics.

In 1947 Friedman attended the opening meeting of the Mont Pèlerin Society, an organization founded by F.A. Hayek and dedicated to the study and preservation of free societies. Friedman would later say that his participation at the meeting "marked the beginning of my active involvement in the political process." His multifold involvement included advising Presidents Richard M. Nixon and Ronald W. Reagan on economic policy, participating in various institutes and societies, and writing a regular column from 1966 to 1984 for Newsweek magazine, in which his articles would alternate with those presenting more liberal views on economic matters, by scholars such as Paul Samuelson and Lester Thurow. Friedman’s public policy positions included support of flexible exchange rates and a monetary growth rule, the promotion of school vouchers, a balanced budget amendment, and the decriminalization of drugs; he opposed conscription and various forms of price controls — from the minimum wage to rent controls.

Friedman’s contributions to economic theory are numerous. One of his earliest, described in A Theory of the Consumption Function (1957), was the articulation of the permanent income hypothesis, the idea that a household’s consumption and savings decisions are more affected by changes in its permanent income than by income changes that household members perceive as temporary or transitory. The permanent income hypothesis provided an explanation for some puzzles that had emerged in the empirical data concerning the relationship between the average and marginal propensities to consume. It also helped explain why, for example, activist fiscal policy in the form of a tax increase, if perceived as temporary, might not lead to the intended reductions in consumption; instead, the increased tax might be financed out of savings, leaving consumption levels unchanged. This was Friedman’s novel finding: if households do not perceive permanent income as changing, they will maintain their established spending patterns.

Friedman’s best-known contributions are in the realm of monetary economics, where he is seen as the founder of monetarism and as one of the successors of the "Chicago school" tradition of economics. In the 1950s macroeconomics was dominated by scholars who adhered to theories promoted by John Maynard Keynes. Keynesians believed in using activist, government-sponsored policy to counteract the business cycle, and they held that fiscal policy was more effective than monetary policy in neutralizing, for example, the effects of a recession. Friedman opposed the Keynesian orthodoxy that "money does not matter," instead promoting the view that changes in the money supply affect real economic activity in the short run and the price level in the long run. He stated his case in his introduction to Studies in the Quantity of Money (1956), a collection of articles that had been contributed by participants in the Money and Banking Workshop. This was followed by an empirical article, The Relative Stability of Monetary Velocity and the Investment Multiplier in the United States, 1897–1958 (1963), coauthored with David Meiselman, in which the stability and importance of the Keynesian multiplier was questioned. The multiplier, forming a link between changes in autonomous expenditure and subsequent changes in national income, is a key element in the Keynesian case for effective and predictable fiscal policy.

In 1963 Friedman published the first of three books he would coauthor with Anna J. Schwartz, A Monetary History of the United States, 1867–1960. Combining theoretical and empirical analysis with institutional insights, this volume provided an intricately detailed account of the role of money in the U.S. economy since the Civil War. Especially influential was the authors’ claim that the Great Depression would have been a typical downturn had it not been for policy errors made by the Federal Reserve.

In 1967 Friedman made another seminal contribution to Keynesian-monetarist debates in his presidential address before the American Economic Association. In it he questioned the validity of another key Keynesian construct, the Phillips curve, which asserted that a stable trade-off exists between the rate of inflation and the unemployment rate. Friedman argued that the trade-off was temporary and depended on workers being "fooled" by unanticipated inflation into thinking that a rise in their nominal wage was a rise in their real wage, thus inducing them to produce more output. According to Friedman, the only way to reduce unemployment below what he dubbed the "natural rate" required not a one-time increase but accelerating inflation. The "stagflation" of the 1970s (literally, a combination of economic stagnation and inflation), impossible in a simplified Keynesian framework, was seen by many as confirmation of Friedman’s hypothesis. It was in any event the death knell for the dominance of the Keynesian model in macroeconomics.

In 1976, the year he retired from the University of Chicago, Friedman was awarded the Nobel Prize in Economics. In 1977 he became a member of the Hoover Institution in Palo Alto, California. About the same time he began work with his wife, Rose, on Free to Choose, a book extolling the virtues of a free market system that eventually led to a Public Broadcasting Service (PBS) television series and a set of educational videos of the same name. In 1998 the Friedmans published their memoirs, Two Lucky People.

Over the course of his career, Friedman made a number of enduring contributions to the field of economics. He became an articulate spokesman for free markets and free societies in an era when many social scientists disparaged market solutions to social problems. Friedman’s collaborative work with Anna J. Schwartz has remained a vital resource for those interested in the monetary history of the United States. Other legacies include Friedman’s revival of a monetary approach to macroeconomics and his persistent critique of the Keynesian orthodoxy of his day.[1]

Free market views

According to Walter Block, "Milton was a beacon of light on issues such as the minimum wage law, free trade, and rent control. ... Milton's valiant, witty, wise, eloquent and yes, I'll say it, inspirational analysis on this issue must stand out as an example to us all. In 1989, he addressed then drug czar Bill Bennett with his "Open Letter" in which he alienated many of his conservative followers with his clarion call for drug legalization. In his Capitalism and Freedom, chapter 9, Milton ripped into the AMA for its policies of restrictive entry into the field of medicine.[2]

In a 1992 study published by the Hoover Institution, entitled "Input and Output in Health Care" (see in full), Friedman noted that 56 percent of all hospitals in America were privately owned and for-profit in 1910. After 60 years of subsidies for government-run hospitals, the number had fallen to about 10 percent. It took decades, but by the early 1990s government had taken over almost the entire hospital industry. That small portion of the industry that remains for-profit is regulated in an extraordinarily heavy way by federal, state and local governments so that many (perhaps most) of the decisions made by hospital administrators have to do with regulatory compliance as opposed to patient/customer service in pursuit of profit. It is profit, of course, that is necessary for private-sector hospitals to have the wherewithal to pay for healthcare.

Friedman's key conclusion was that, as with all governmental bureaucratic systems, government-owned or -controlled healthcare created a situation whereby increased "inputs," such as expenditures on equipment, infrastructure, and the salaries of medical professionals, actually led to decreased "outputs" in terms of the quantity of medical care. For example, while medical expenditures rose by 224 percent from 1965–1989, the number of hospital beds per 1,000 population fell by 44 percent and the number of beds occupied declined by 15 percent. Also during this time of almost complete governmental domination of the hospital industry (1944–1989), costs per patient-day rose almost 24-fold after inflation is taken into account. The more money has been spent on government-run healthcare, the less healthcare was gotten.[3]

Friedman referred to this as the Gammon's Law, where in "a bureaucratic system . . . increase in expenditure will be matched by fall in production. . . . Such systems will act rather like `black holes,' in the economic universe, simultaneously sucking in resources, and shrinking in terms of `emitted production.'" As he put it: "I have long been impressed by the operation of Gammon's law in the U.S. schooling system: Input, however measured, has been going up for decades, and output, whether measured by number of students, number of schools, or even more clearly, quality, has been going down."[4]

Monetary views

Milton Friedman advocated a fiat or paper money standard guided by a monetary rule of an annual expansion of the money supply at a fixed rate because he believed that it was less costly than a gold standard, less open to inflationary excess, and more likely to provide the monetary framework for general economic stability.

But by the mid 1980s, Friedman had second thoughts about whether government could be trusted ever to follow the necessary restraint to provide this supposedly superior paper money system. He began to regularly quote a sentence from Irving Fisher's 1911 book, The Purchasing Power of Money: "Irredeemable paper money has almost invariably proved a curse to the country employing it."

In July 1985, Milton Friedman delivered the presidential address at the Western Economic Association on the topic "Economists and Economic Policy," which was published in the January 1986 issue of Economic Inquiry. He stated that his many years in advocating a monetary "rule," under which the central monetary authority would increase the money supply at a constant annual rate regardless of changing economic conditions, had been a waste of time. The reason, he said, is that there is no basis for thinking it would ever be in the interest of those who managed the government monetary system to follow such a rule:

"Most of my own work dealing with public policy has had the same character of proceeding as if I were addressing governmental officials selflessly dedicated to the public interest. I have attempted to persuade the Federal Reserve System that it was doing the wrong thing and it ought to adopt a different policy. This time was ill-spent - because the public-interest characterization of government is basically flawed.... We do not regard a businessman as selflessly devoted to the public interest. We think of a businessman as in business to improve his own welfare, to serve his own interest.... Why should we regard government officials differently? They too aim to serve their own interest, and in government as in business we must try to set up institutions under which individuals who intend only their own gain are led by an invisible hand to serve the public interest. The Federal Reserve System puts a great deal of power in the hands of a few people and it is so constructed that it has been in their self-interest to pursue a policy which, I believe, has been very harmful for the public rather than helpful.... Clearly, it was not in the self-interest of the Federal Reserve hierarchy to follow the hypothetical policy [of a monetary rule]. It was therefore a waste of time to try to persuade them to do so." [5]

In June 1986, Friedman published a short article in the Journal of Political Economy entitled "The Resource Cost of Irredeemable Paper Money." He said:

"In earlier discussions, other monetary economists and I took it for granted that the real resource cost of producing irredeemable paper money was negligible, consisting only of the cost of paper and printing. Experience under a universal irredeemable paper money standard makes it crystal clear that such an assumption, while it may be correct with respect to the direct cost to the government of issuing fiat money, is false for the society as a whole."

Friedman pointed out the long-term price instability in a fiat money regime and the significant costs associated with it:

growth of the "hard money" industry

the introduction of money market mutuals in the US, reduction of the role of commercial banks, deregulation of banking institutions and accompanying banking crises (such as the Continental Illinois, Ohio, and Maryland crises)

development of public futures markets in foreign exchange and in financial instruments to deal with price uncertainty

Friedman concluded that "the direct resource cost of the gold and silver accumulated in private hoards [in the 1970s and 1980s] may have been as great as or greater than it would have been under an effective gold standard." And while such commodity and currency futures markets "serve a useful function by enabling economic agents to hedge against uncertainty and undertake long-term commitments ... nevertheless ... they would not have arisen if the new [paper] monetary regime had not led to greatly increased uncertainty about interest rates and inflation."[6]

Also in 1986, Friedman coauthored an article with Anna Schwartz that asked the question, "Has Government Any Role in Money?" They concluded that in principle it did not need to have one and historically sometimes had none. They argued:

"The apparently great value to the economy of having a single unit of account linked with an (ultimate) medium of exchange does not mean that government must play any role, or that there need be a single producer of the medium of exchange. And indeed, historically, governments have entered the picture after the event, after the community had settled on a unit of account and private producers had produced media of exchange.... Historically, producers of money have established confidence by promising convertibility into some dominant money, generally specie [e.g., gold or silver]. Many examples can be cited of fairly long-continued and successful producers of private moneys convertible into specie. We do not know, however, of any example of the private production of purely inconvertible fiduciary moneys."

They stated: "Our own conclusion ... is that leaving monetary and banking arrangements to the market would have produced a more satisfactory outcome than was actually achieved through government involvement."[7]

However, they did not argue for a return to a gold standard. In his article on irredeemable paper money, Friedman made this point very clear:

"Let me emphasize that this note is not a plea for a return to a gold standard.... I regard a return to a gold standard as neither desirable nor feasible — with the one exception that it might become feasible if the doomsday predictions of hyperinflation under our present system should prove correct."

Why wouldn't a market-based gold standard be feasible or desirable under present circumstances? Friedman explained his reasoning in an April 1976 lecture entitled "Has Gold Lost Its Monetary Role?" that was delivered in Johannesburg, South Africa. Simply put, governments are no longer willing to be restrained by a gold standard. They want control over money for various macroeconomic manipulative purposes. However, Friedman said that

"if you could re-establish a world in which government's budget accounted for 10 percent of the national income, in which laissez-faire reigned, in which governments did not interfere with economic activities and in which full employment policies had been relegated to the dustbin, in such a world you might be able to restore a real gold standard. A real honest-to-God gold standard is not feasible because there is essentially no government in the world that is willing to surrender control over its domestic monetary policy."[5]